What is Capital Gain?

The term capital gain refers to the profit you realise from the sale of a capital asset. In simple terms, it is the positive difference between the amount you receive from selling an asset and the amount you initially paid for it after accounting for the costs associated with the asset’s purchase and sale.

According to the provisions of the Income Tax Act of 1961, capital gains are not included as part of your total income. Instead, it is listed under the special heading ‘Income from Capital Gains’ and is taxed at a special rate.   

One of the key characteristics of capital gains is that they are only recognised and taxed when a capital asset is sold or transferred to another person or entity. The concept of capital gains does not arise if the asset simply appreciates in value without undergoing a sale or transfer.

What are Capital Assets?

To fully understand capital gains, we must first grasp the concept of capital assets. The Income Tax Act of 1961 provides a comprehensive definition of what constitutes a capital asset. 

According to section 2(14), a capital asset is defined as any property held by a person or an entity. As you can see, the definition is quite broad and encompasses a wide range of assets, such as:

• Immovable property like land and buildings
• Movable property like jewellery, vehicles, archaeological collections, artwork, drawings, paintings, and sculptures
• Financial securities like stocks, bonds, and mutual funds 
• Intangible assets like patents, trademarks, and copyrights 

However, section 2(14) of the Income Tax Act excludes certain assets from the purview of capital assets. Here is a quick overview of what they are. 

• Stock-in-trade, raw materials, or other assets held for business purposes
• Personal effects such as clothing and furniture
• Agricultural land in rural areas
• Gold bonds issued by the government of India
• Special-bearer bonds
• Unit-Linked Insurance Policy (ULIP) that is exempted by Section 10(10D) of the Income Tax Act

Since the assets listed above are not classified as capital assets, the profits from their sale will not be considered capital gains. 

Types of Capital Gains 

In India, capital gains are categorised into two types based on the asset's holding period. This classification is crucial as it determines the applicable tax rates and available exemptions. Here is a quick overview of the two different types of capital gains. 

• Short-Term Capital Gains

Short-Term Capital Gains, or STCG, refers to the gains realised from the sale of capital assets held for a short duration. The holding period that qualifies as 'short-term' varies depending on the type of asset. 

• Long-Term Capital Gains 

Long-Term Capital Gains, or LTCG, refer to gains from the sale of capital assets held for a period longer than what qualifies as short-term. Here is a table outlining how long you must hold different assets for them to qualify as long-term capital assets.

Computation of Capital Gains 

The calculation of capital gains might seem straightforward, but it involves several components and considerations. Here is a detailed look at how these gains were computed in India before and after the changes introduced in the Union Budget 2024. 

• Short-Term Capital Gains 

The mathematical formula that is used to compute short-term capital gains is as follows: 

STCG = Full Sale Value - (Cost of Acquisition + Cost of Improvement + Expenses in Connection with the Sale or Transfer)

Here, the full sale value refers to the selling price of the asset. In the case of property transactions where the selling price is less than the stamp duty value, the stamp duty value is considered the selling price. 

Meanwhile, the cost of acquisition refers to the purchase price of the asset. In the case of inherited assets or gifts, the cost to the previous owner is considered the cost of acquisition. The cost of improvement refers to the expenses incurred to improve the asset's value after its acquisition. Finally, the expenses in connection with the sale or transfer include brokerage, commission, and legal fees, among others, incurred during the sale of the asset.

• Long-Term Capital Gains

Before Union Budget 2024, the Income Tax Act of 1961 provided indexation benefits to taxpayers for long-term capital gains. With the indexation benefit, taxpayers can adjust the cost of acquisition and improvement of their assets for inflation using the Cost Inflation Index (CII). CII for every financial year is published by the Income Tax Department (ITD) on their official website. Here is the formula used to compute LTCG before the introduction of the Union Budget 2024. 

LTCG = Full Sale Value − (Indexed Cost of Acquisition + Indexed Cost of Improvement + Expenses in Connection with the Sale or Transfer)

The indexed cost of acquisition or improvement can be computed using the below-mentioned formula: 

Indexed Cost = Original Cost of Acquisition or Improvement × (CII of the year of sale ÷ CII of the year of acquisition or improvement)

Budget 2024 Update

The Union Budget 2024 introduced on July 23, 2024, brought changes to the way long-term capital gains were calculated. It completely removed the indexation benefit in exchange for a lower tax rate. This applies to all assets purchased after July 23, 2024. With this change, the formula for calculating LTCG would be as follows: 

LTCG = Full Sale Value - (Cost of Acquisition + Cost of Improvement + Expenses in Connection with the Sale or Transfer) 

That said, in the case of assets purchased before July 23, 2024, taxpayers will be provided the option of choosing between computing LTCG with indexation benefits and paying tax at a higher rate or computing LTCG without any indexation benefits and paying tax at a lower rate.          

Capital Gains Tax Rates in India

The capital gains tax rates in India vary based on the type of asset, the duration of holding, and the type of gain (short-term or long-term). Here is a breakdown of the capital gains tax rates before and after the changes introducedWhenever you sell an asset, be it property or equity shares, you must pay tax on the profits you get from the sale. Understanding how these profits, termed capital gains, are calculated and taxed is crucial for proper financial and tax planning. In this article, we are going to comprehensively explore the concept of capital gains and how they are treated under the Income Tax Act of 1961.     

What is Capital Gain?

 in the Union Budget 2024:

Also Read: What is Interest on Income Tax Refund?

Conclusion

Understanding the concept of capital gains and how they are taxed is crucial, not just for seasoned investors but for anyone looking to build and manage wealth effectively. Now, it is important to remember that the landscape of capital gains taxation is ever-changing. To make informed decisions as an investor, you must remain updated on the various changes as and when they are introduced. This way, you can plan your investments more efficiently.

If you wish to enhance your investment strategies, the tools available on Motilal Oswal's Research 360 platform can be invaluable. With in-depth market analysis, portfolio management tools, and comprehensive research reports, the platform helps you navigate the complexities of the financial markets. Although it may not offer tips or advice on how to plan your taxes, the insights that it offers can be used to make tax-efficient investment decisions.